A Family Limited Partnership (FLP) (note that a Limited Partnership and Family Limited Partnership are really the same thing), can be a good Personal Asset Protection tool. The Asset Protection provided by an FLP is essentially the same as the FLP – it is the Charging Order Protection (the non-seizability of the Partnership Interest) that serves as the protection.
The FLP should only be used to hold assets and generally should not be used for conducting business (note that a Limited Partnership can be used effectively as a business entity – but, due to General Partner liability for a Limited Partnership, proper structuring is critical to avoid any individual from being personally stuck with the business’s liability). The reason for this is primarily due to the fact that the General Partner of the FLP is, by law, liable for the debts and the liabilities of the FLP. As such, if the FLP itself does business with outsiders and it gets sued and a judgment is won against the FLP, the General Partner may be stuck personally with that liability as well as the FLP. In order to avoid any individuals from being exposed to the company’s liabilities, it is very important that the General Partner not be an individual or an entity that owns other valuable assets or that otherwise has value. Preferably, the General Partner should be an FLP, a Corporation or a Trust.
In terms of “back-end” protection (when we are talking about “back-end” protection, we are talking about the protection of your equity ownership interest in the FLP), the FLP provides good protection. For this reason, FLP’s have traditionally been viewed favorably for personal asset protection planning, as well as estate and business planning.
The FLP’s back-end protection is what is generally referred to as “Charging Order Protection.” What this means is that the Charging Order is that in Nevada the exclusive remedy of a Judgment Creditor – and that remedy in Nevada is essentially a sit-and-wait-and-hope-the-FLP-is-dumb-enough-to-make-a-distribution-remedy. Specifically, the Judgment Creditor of a partner of a Nevada FLP do anything but “lien” or “charge” the partner’s right to receive distributions of profit when and if distributions are made. In Nevada, the Judgment Creditor of a partner cannot foreclose the Charging Order (which is essentially a lien) or exercise any other remedy against the FLP.
If a Judgment Creditor has a Charging Order against an FLP partner’s interest, the Judgment Creditor does not aquire any rights of the FLP partner other than the right to receive the distributions made from the FLP to the partner when, and if, a distribution is made to the partner that is the Judgment Debtor. The Judgment Creditor cannot force any distribution of profits. Hence, if no distribution is made, the Judgement Creditor receives nothing. The General Partner of the FLP stays in control of when distributions are made. Thus, the Judgment Creditor will receive nothing unless, and until, the General Partner authorizes and makes a distribution of profit to the partners.
Notwithstanding the Charging Order possibility, there is a big disincentive for a Judgement Creditor to want to get a Charging Order. This is because the Charging Order only gives the Judgment Creditor the right to receive the distribution of profits made to the Judgment Debtor a partner of an FLP when such distributions are made. Due to that fact, the IRS has taken the position that the Judgment Creditor with a Charging Order has become a “financial partner” of the FLP. This is problematic for the Judgment Creditor, because the FLP is a “flow-through” tax entity (net profits and losses “flow-through” to the partners and are attributed to the FLP partners, regardless of whether or not any actual profit distributions are made). What this means for the Judgment Creditor is that, if there is a net profit made in the FLP, the Judgment Creditor that has a Charging Order against an FLP partner’s partnership interest may end up paying taxes on profits that the Judgment Creditor will likely never see (IRS Revenue Ruling 77-137) because the partner’s share of the net profit from the FLP is attributed to the financial partner. Therefore, no Judgement Creditor in their right mind would want to risk getting a Charging Order. This effectually translates into protection from liens against your right as a partner of the FLP to receive distributions of profits from the FLP. (this is commonly referred to as the “K-O by the K-1”)
The “good” part of the FLP back-end protection is that Judgment Creditors can’t seize the partnership interest in the FLP. The Judgment Creditor is also prevented from forcing or taking the profit distributions, foreclosing against the lien, voting the FLP partner’s voting interests in the FLP, or from exercising any other remedy against the partnership interest (this is particularly true in Nevada where the Nevada FLP law makes the “sit and wait” charging order the exclusive remedy for the Judgment Creditor. The Judgment Creditor is also prevented from getting into the FLP to get at the assets of the FLP.
The limitation of the FLP Asset Protection is that a Judgment Creditor (either with a charging order or a ready garnishment) can effectually prevent you taking your money out of the FLP to yourself where you can use it for your personal needs (and using FLP “business” money to pay personal expenses can put FLP assets at risk to attempts by the Judgment Creditor to do a reverse veil piercing). So, bottom line is that an FLP is a good first step to Personal Asset Protection.
Having a Nevada Asset Protection Trust own the FLP partnership interest for you puts you in far more ideal and secure position. CLICK HERE TO LEARN MORE ABOUT THE NEVADA ASSET PROTECTION TRUST